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Sterling devaluation: Cause and effect

by Frank Schnittger Sun Aug 20th, 2017 at 08:57:59 PM EST

My central expectation, repeated in numerous blog posts and comments since the referendum, is that we will see a hard Brexit (defined as one without a substantive Brexit or post Brexit trade deal) accompanied by at least a 30% devaluation of Sterling relative to the Euro.  

Faced with such a devaluation EU policy makers will have little option but to impose tariffs on imports from the UK, if only to preserve the competitiveness of the EU's own industries. If the UK retaliates with tariffs of its own, a hard Brexit will result in a trade war, even worse than the worst case scenario of "no deal" Brexit Pundits, all of whom seem to expect standard WTO tariffs to kick in at that stage.

My point has always been that WTO tariffs have to be negotiated, and there simply isn't any automatic process by which some default set of tariffs will kick in once the UK leaves the EU.

But the 30% relative devaluation figure was always a "finger in the air" guess. It now looks as if I might have been too conservative in my prognostication. Sterling has already declined from 77P to the Euro to 91P to the Euro - a devaluation of 18% since the referendum. Morgan Stanley are now predicting that the euro will trade at £1.02 by the end of the first quarter of 2018 - a total devaluation of 32.5% - and that is before we even know the exact shape that Brexit will take...


Sterling devaluation has already wiped out several Irish mushroom producers, and the Irish Agri-food business  - heavily dependent on the huge UK food market - faces collapse when Sterling approaches parity with the Euro.  

The obvious solution - diversification into EU27 markets - is difficult as those markets are already saturated, and emerging markets such a China are a slow burn, at best. The reality is that Brexit has effectively already happened for many Irish food producers tied into Sterling denominated contracts, and the only solution, ironically, might be a very hard Brexit which effectively blocks UK agricultural exports into the EU27, enabling Irish exporters to take their place.

At the moment the UK does effectively have its cake while eating it, with an 18% devaluation enhancing UK competitiveness even as the prospect of Brexit takes it's toll on business investment and consumer confidence. UK tourism to the Republic of Ireland is already down by 4% even as tourism from the rest of the EU and the Americas booms.

For Irish business, particularly in the agri-food sector with its traditionally tighter margins, Brexit is no longer some hard to define future threat on the horizon. It is a reality now.

While the Irish government has been arguing for as soft a Brexit as possible to ameliorate damage to North south trade and the peace process in Northern Ireland, it may soon be forced to argue for a much tougher EU stance: one which effectively bars UK agri-food exports to the EU.

Watch this space.

Display:
My central expectation, repeated in numerous blog posts and comments since the referendum, is that we will see a hard Brexit...
<Snip>
My point has always been that WTO tariffs have to be negotiated, and there simply isn't any automatic process by which some default set of tariffs will kick in once the UK leaves the EU.

I´m not quite sure if I understand you correctly. Or maybe I don´t know all the facts?

But it was my impression that Britain - in a hard Brexit scenario - will simply become a third party country. And in such a scenario the EU will be forced to implement third party country duties.
Otherwise the EU would violate the WTO non-discrimination rules.

Third party country duties here would be the tariffs as reported to the WTO?

by Detlef (Detlef1961_at_yahoo_dot_de) on Mon Aug 21st, 2017 at 11:56:04 AM EST
There may not be "any automatic process by which some default set of [WTO] tariffs will kick in", but there is agreement among signatories "cut and bind" tariffs declared in any trade agreement between signatories to bound rates and applied rates which may NOT exceed maximum amounts acceptable to all 123 signatories. To "cut" is to decrease duties demanded by any party, since Uruguay Round.

UNDERSTANDING THE WTO: BASICS

GET TARIFF DATA

Though spectators admit UK gov't exit from EU-WTO commitment poses practical challenges in creating bi-lateral treaties with 123 nations, few have admitted UK gov't unilateral strategy to increase customs rates on any counterparty will immediately provoke WTO panel arbitration.

For this reason as well as declining domestic demand for imported goods and services (weak PPP), expecting growth of UK customs revenue is improbable.

Diversity is the key to economic and political evolution.

by Cat on Mon Aug 21st, 2017 at 03:32:17 PM EST
[ Parent ]
World Tariff Profiles 2017 provides comprehensive information on the tariffs and non-tariff measures imposed by over 170 countries and customs territories.

This is a 250pp WTO publication which you may download (digital format) free of charge. More detailed statistical reporting is offered elsewhere at the website.

Diversity is the key to economic and political evolution.

by Cat on Mon Aug 21st, 2017 at 03:40:59 PM EST
[ Parent ]
How dare the WTO violate our sovereignty like that? If you're right, we need a referendum on leaving the WTO. Farage, what are you waiting for?
by gk (gk (gk quattro due due sette @gmail.com)) on Mon Aug 21st, 2017 at 04:07:17 PM EST
[ Parent ]
Trump to denounce UK currency manipulation?

Diversity is the key to economic and political evolution.
by Cat on Mon Aug 21st, 2017 at 04:21:39 PM EST
[ Parent ]
The difficulty is that the UK will effectively be a new WTO member without any detailed schedules of Tariffs agreed with other WTO members. Thus, in the absence of any bilateral agreement to the contrary, there is nothing to prevent the EU applying the maximum tariffs permissible under WTO rules, even if it has given much greater concessions to other trading partners as part of bilateral trade deals.

The UK would then be trading with the EU at a disadvantage when compared to other nations which do have bilateral trade deals with the EU. Similarly there is no reason why other third countries like (say) India must give the UK the same concessions they have given the EU and every reason why they might not (size of market, history, geopolitical tensions etc.).

To get an idea of the effect of this I refer you to this paper.

Abstract: The UK exit from the European Union (Brexit) is likely to have a range of impacts, with trade flows likely to be most affected.  One possible outcome of Brexit is a situation where WTO tariffs apply to merchandise trade between  the  UK  and  the  EU.  By  examining detailed  trade  flows  between the UK and all other EU members, matching over  5200  products  to  the  WTO  tariff  applicable to  external  EU  trade this paper shows that such an outcome would result in significantly different impacts across countries. Our estimates of exposure at the country level show an extremely wide range with reductions in trade to the UK falling by 5% (Finland) to 43% (Bulgaria) taking into account the new tariffs and the elasticity of the trade response to this price increase.  Food and textiles trade are the hardest hit, with trade in these sectors reducing by up to 90%


Index of Frank's Diaries
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Mon Aug 21st, 2017 at 05:36:12 PM EST
[ Parent ]
It is worth noting that the paper above assumes the EU and UK would apply minimum, not maximum WTO Tariff rates. Assuming these tariffs feed directly into prices results in the following impacts on EU UK trade depending on which assumptions for price elasticity are made for each sector:

Median elasticity assumption results in a  fall  in  EU  to UK trade by  30% and a 22% reduction in UK to EU trade. The mean elasticities  are  slightly  higher  and  would  generate falls of 37% in EU-UK trade and 27% in UK-EU trade. The upper and lower bounds of the estimates are  given by the maximum elasticity estimates which would generate trade falls of 56% and 45% in EU-UK and UK-EU  trade respectively  and  the minimum  estimates  would result in trade declines of  17% and 12% respectively.

These are massive reductions in trade and are based on Minimum WTO tariffs.

And non of the above takes into account the effect of devaluation, which will devastate EU-UK trade much further.

Index of Frank's Diaries

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Mon Aug 21st, 2017 at 06:33:15 PM EST
[ Parent ]
Again. I think it prudent to examine tables in the WTO's 2017 publication in order to obtain at least a more accurate understanding of bound and applied rates in effect AND ratio of premia >15% (applied to scheduled G&S) by signatory.

EU's ratio is extremely low --AS IS "free trade" commitment-- by comparison to that which so-called developing nations impose on imports from any and all trade "partners". And you can bet that 0.4 summarizes trade sanctions imposed on NATO's "adversaries."

Compare that benchmark to current costs of EU interstate tariffs which the UK loses as "third-country". Between member countries customs duties are forbidden. EU need not declare a new CCT regime in order for UK gov't to appreciate the "disadvantages" of out-group, international sovereignty ... unless the UK gov't declares itself a NATO adversary. Then you may expect a truly frosty welcome to the "special relationship."

But whichever cost the other 99.6% bear is sufficient to tip the UK into a permanent state of insanity or piracy. As it is, no one can say if the gov't has prepared for any EU demand for reimbursement of the cost of inspection and compliance (abrogated by UK in its retarded position paper) on to the balance of charges on EU budget outstanding.

For example in March OLAF slammed lax UK border controls and recommended the European Commission reclaim €2 billion the agency said was lost because Britain had failed to apply the correct EU duties on imports of Chinese clothes and footwear in recent years.

Then, there's the whole move of euro-denominated R&D and derivatives trading out of the City. ISDA shure as shinola isn't paying for that.

Diversity is the key to economic and political evolution.

by Cat on Mon Aug 21st, 2017 at 08:50:01 PM EST
[ Parent ]
A challenge for some eurotrib readers remains: Explain why the EU will permit the UK to set cost-free, "frictionless" legal precedent for any member's secession from the union.

Diversity is the key to economic and political evolution.
by Cat on Mon Aug 21st, 2017 at 09:02:09 PM EST
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Mon Aug 21st, 2017 at 11:00:04 PM EST
[ Parent ]
That's an explanation.

Diversity is the key to economic and political evolution.
by Cat on Tue Aug 22nd, 2017 at 01:46:53 AM EST
[ Parent ]
It is a denial of the premise which obviates the need for an explanation.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Aug 22nd, 2017 at 01:07:43 PM EST
[ Parent ]
Not a denial as much as a rebuttal: the UK currently enjoys "frictionless" trade, financial services and plenty of other things with the rest of the EU28, as a member of said EU.

Once out of the EU, there is no reason for the remaining 27 to grant the UK the same facilities. As W.Schaüble put it bluntly: "In is in, out is out".

The few non-EU countries who have free trade agreements with the EU (Norway, Switzerland) had to take all the strings attached, starting with freedom of movement - the very thing which is anathema for many Brexiters.

by Bernard on Tue Aug 22nd, 2017 at 07:53:38 PM EST
[ Parent ]
That is a explanation. Thank you.

The former replies denote unstated assumptions. Not cricket at all in the position paper writing business.

Diversity is the key to economic and political evolution.

by Cat on Wed Aug 23rd, 2017 at 12:51:37 PM EST
[ Parent ]


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